Recently, politicians and economists alike have promoted home refinancing as one of the keys to jumpstarting the American economy. While your motivations may be less high-minded, it makes sense for military homeowners who have not recently done so to consider refinancing. Record low mortgage rates will help you lock in lower monthly payments, save on the total cost of your loan, and free up cash that you can use to pay down debt or purchase other necessities.
This article will serve as a basic primer on home refinancing – how it works, when to use it, and what to expect in today’s banking climate. We will also look at a specific refinancing program for military families.
How it Works
A home refinance replaces your original home mortgage with a new loan for the outstanding principal amount with better terms in order to lower the monthly payment, reduce the interest paid on the loan, or shorten the loan term. In most cases, this is done to free up extra money that would traditionally go towards your monthly mortgage.Some homeowners might also consider a cash-out refinance. This is a loan for greater than the outstanding principal that allows you to extract extra cash. This cash could be used for a home improvement project, to pay for another large expense, or to pay down debt. For the purposes of this article, we will focus on a traditional refinance only.
In both cases, the key criteria will be your credit score, the amount of equity one has in his/her home (also known as LTV: loan to value), and your debt to income ratio - or simply put - how much you spend against how much you make. Underwriters will also review your assets, conduct a credit check, and require an appraisal and title check (to make sure you own it) of your home. If you are approved for the loan, be aware that there are usually closing costs and fees associated with it.
You can follow this link for a quick guide on understanding mortgage loans and a glossary of terms including interest rates, points and other basic mortgage keywords: www.bills.com/mortgage/.
Making the Right Decision
There are a number of factors to consider when deciding if a home refinance is right for you. The first is making sure you understand your options.
There are two main categories of loans – fixed rate loans and variable rate loans. Fixed rate loans will maintain the same interest rate over the entire loan term. These are generally good for people who plan to remain in their home for a long period of time or who are seeking stability in their monthly expenses. Variable rate loans have an artificially low rate and payment for a short term before adjusting to a balloon payment or a market-adjusted interest rate. These can be a smart choice for individuals looking to move or sell within a few years, or for those who are willing to exchange a lower payment today for a potentially higher payment in the future.
Fixed rate loans are generally available in 30-year, 20-year or 15-year terms. The 30-year term provides the lowest monthly payment of the three, but also the highest total amount of interest paid as part of the loan. With historically low interest rates, many homeowners are opting for a 15-year term as a way to pay less total money for their loan, even though the monthly note can be slightly higher. In all cases, be sure to understand that with a refinance you are restarting your home loan in exchange for these lower payments or rates. This is important as mortgage loans are set up in a way that requires the borrower to pay a much larger portion of interest in the first few years of the loan term, in place of paying down the principal balance of the loan.
Variable rate loans are generally available in 5-year or 7-year options. If you plan to leave your home within one of these windows, it could make sense to choose a variable rate because your monthly payment will be much lower than a fixed rate loan. However, if you stay in your home past this term then you could find yourself with a much higher monthly note. At the same time, be sure to calculate the closings costs associated with the loan – you want to be sure you remain in the home long enough to recoup your costs through the new savings.
You can use a Refinance Calculator to determine if a refinance might make sense for you. As with any loan, you should shop for the best rates and terms across multiple lenders to be sure you are securing the best deal on your refinance.
Military families and servicemembers have access to a unique VA loan product called the Interest Rate Reduction Refinancing Loan (IRRRL) or “streamline” loan. This program makes it easier and more affordable than most private loans to refinance your existing VA loan into a new one.
In a streamline loan, the VA does not require an appraisal or credit-underwriting package (although your lender may require this), and a certificate of eligibility is not necessary. Additionally, the loan can be completed as a “no money out of pocket” loan where the costs are rolled into the loan or the interest rate is high enough to cover lender fees.
The program does require that you currently hold a VA home loan, although there is no current occupancy clause – only that you previously occupied the home. The program also necessitates that you receive a lower interest rate than your original loan (unless you’re refinancing from a variable rate to a fixed rate loan), and that you not take cash out of the refinance. There is a separate program for this. However, you can include up to $6,000 of energy efficiency improvements into the loan.
Any lender can execute a streamline loan, so do not be taken in by lenders that tell you they are the only qualified lender. In fact, it makes sense to shop your loan around to multiple lenders to make sure you are getting the best deal. More information is available here: www.military.com/money/va-loans.
What to Expect
If you haven’t visited a lender or spoken with a credit card company in the past few years, then the biggest change you’ll notice is that it’s much harder to secure a loan now. Lenders have raised their thresholds for approval. You’ll need a credit score of higher than 720 and at least 20 percent equity in your home to qualify for the best loans (if your credit score is below 600, it can be difficult to qualify for a loan in today’s market). Even if you meet these limits, be prepared to wait. Lenders are demanding more documentation from homeowners, and there is a flood of applications for approval right now – extending the approval time dramatically. But if you are qualified and patient, then the rewards of a refinance can be worth the wait with potential savings of hundreds of dollars per month.
---Ethan Ewing manages Bills.com, a website business which provides practical financial advice and resources to everyday people. Prior to joining Bills.com, Ethan was a Vice President for Experian Interactive, a leader in online marketing and advertising, where he was responsible for developing online partnerships with many of the internet's largest properties. Check out www.Bills.com/IQ to get your free BillsIQ score and find out how financially fit you are.